2021 was a disappointing year for gold bugs, with an annual loss (YTD) of 4.2%. In contrast, the S&P 500 is up nearly 17%. Other commodities like copper and oil were also quite strong in 2021, with gains of 27% and 53% respectively.
The underperformance of gold is puzzling, especially since one can hardly imagine more optimistic circumstances for the yellow metal. For the past 2 years we have had massive deficits leads to lower tax revenues and significantly higher expenses due to the coronavirus. Overall, the deficit was $ 3.1 trillion in 2020 and is estimated at $ 3 trillion this year. In addition, central banks around the world cut rates and bought assets to ensure the financial system remained solvent and liquid. In addition, inflation was also quite strong, reaching multi-year highs.
I believe that gold’s underperformance during a period of strong fundamentals is an ominous harbinger of its near-term outlook. Additionally, there are some declining catalysts that could result in more sales.
Here are three reasons to be pessimistic about gold for the remainder of 2021:
- Deviation from real interest rates
- The Federal Reserve lays the seeds for tapering
- Bitcoin is now an alternative asset to protect against currency depreciation
Real interest rates
Just as profits ultimately determine stock prices, so gold prices are largely determined by real interest rates. This can be seen in the graphic above.
It also makes sense from a logical point of view. When real interest rates rise, holding gold is less attractive as short-term government bonds allow investors to earn positive, risk-free returns. At the same time, when real interest rates fall, the demand for gold as a store of value increases, while the yield on short-term government bonds dwindles due to inflation.
Right now we have a divergence with real rates hitting a lower low while gold hitting a lower high. In late 2018, we saw a similar divergence in the opposite direction as gold hit higher low while real rates hit higher high.
This also marked a major tipping point for the price of gold, climbing from $ 1,200 to over $ 2,000 over the next 20 months.
The Federal Reserve lays the seeds for tapering
Another reason to be pessimistic about gold is that real interest rates are likely to rise. One factor is that the Fed is clearly laying the seeds for tapering. Tapering is when the Fed is slowing the pace of large-scale asset purchases.
At his last meeting, Fed Chairman Jerome Powell said the economy had made progress towards its goals. The increase in Covid cases due to the Delta variant also did not seem to be of major economic concern to him.
In return, Fed Fund Futures Markets responded to the decision as the likelihood of a 25 basis point hike rose from 10% to 23% by the Fed meeting in September 2022. The chances of a 25 basis point increase by the December 2022 meeting rose from 19% to 38%. Most expect the Fed’s tightening to begin about a year before the first rate hike.
Of course, the Fed’s current slow and gradual path in reducing accommodation also depends on the recent surge in inflation being “temporary”. While significant disagreements remain on this issue, recent evidence suggests that the Fed’s judgment is correct as some of the components most responsible for the rise in inflation are starting to cool. Notable examples are timber prices, apartments, and used cars.
This combination of falling inflation and tighter monetary policy would lead to higher real interest rates, which would lead to gold sales.
I believe the advent of bitcoin is another reason to be pessimistic about gold. In fact, many investors buy Bitcoin because it is considered a “store of value” as its total supply is fixed.
It is no accident that this reflects the argument that gold bulls have been making for decades. Both camps point to the Fed’s growing balance sheet, long-term dollar depreciation and growing money supply as reasons why people should invest in real assets.
Given Bitcoin’s strong performance over the past decade, especially when compared to gold, it is more attractive to younger investors. While gold is an asset class that institutions have been investing in for decades, Bitcoin is still in its infancy accepted by investors.
Because of these factors, I believe that Bitcoin could cannibalize some of the gold demand and be a factor in its recent underperformance compared to its fundamentals.
The performance of gold in 2021 should certainly raise the red flags, especially since one can hardly imagine more favorable circumstances. I believe demand could fall as real rates rise and the Fed prepares to cut asset purchases. Finally, the strong performance and growing institutional interest in Bitcoin is another factor that could detract from gold’s attractiveness as a “store of value”.
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GLD shares traded at $ 169.39 per share on Tuesday afternoon, down $ 0.22 (-0.13%). Since the beginning of the year, the GLD has fallen by -5.03%, compared to an increase in the reference index S&P 500 of 18.56% over the same period.
About the author: Jaimini Desai
Jaimini Desai has been a financial writer and reporter for nearly a decade. Its aim is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth Newsletter. Find out more about Jaimini’s background, as well as links to his latest articles. More…